On the riots in Mozambique: Are subsidies the solution?

The recent riots in Maputo were triggered by increases in the cost of living, and they raised concerns of a possible repeat of the 2008 food and fuel price crisis around the world.

But this time the riots were at least as much the result of misguided domestic policies as of international price volatility.

In the run up to the October 2009 elections, the government pursued populist policies of keeping the exchange rate overvalued, subsidizing fuel prices, and freezing any increases in tariffs of public utilities.

These interventions have been progressively undone in 2010. In the year to July 2010 the metical depreciated by approximately 30 percent with respect to the US Dollar and the South African rand, and by some 20 percent against the Euro.

The impact of these adjustments was compounded by the upward trend in food and fuel prices in recent months, resulting in a rapid increase in the cost of living. This created significant difficulties for the poorest, already struggling to buy food and basic necessities.

So when a new round of price increases was announced for September 6, including water and electricity tariffs, but most important an approximately 20 percent rise in the price of bread, violent protests erupted.

The government did a swift u-turn and reinstated the subsidies, emphasizing that this was necessary to protect the poor. There is little doubt that this was a wise measure to calm down the situation, and design an adequate long-term response. But these subsidies are no panacea for the poor. In fact, they are highly regressive.

Approximately 70 percent of the money spent on fuel subsidies goes to the richest 20 percent of the population, and almost none of it reaches the poor (see graph)1. Approximately 60 percent of subsidies for household electricity consumption benefit the richest quintile and only 4 percent benefit the poorest quintile. Even in the case of bread, as much as 42 percent of a subsidy to wheat flour benefits the richest quintile and only 6 percent reaches the poorest quintile.2

To be sure, the measures the government introduced a few weeks ago were more pro-poor: the increases in utility tariffs were frozen for low consumption volumes, but were maintained for higher consumption levels; similarly the removal of the (very low) import tariff on rice was only for 3rd class rice. On fuel, the government announced the intention to move to subsidizing urban transport which is clearly less costly and better targeted to the poor than the current blanket diesel subsidy.

However, the general point is that the existing subsidies (to fuel, electricity, water, and now bread) mostly benefit the rich. The government should replace these subsidies with better targeted social protection programs that really benefit the poor.

Now that things have calmed down, the government needs to encourage an open debate about who really benefits from the existing subsidies. This would also be an opportunity to focus on the real problem, namely that despite very high GDP growth rates, Mozambique’s current development strategy is not working.

The current development model focusing on public investment in infrastructure, attracting mega projects (which are capital intensive), and increasing access to public services (education, health, water and electricity, and more recently subsidized fuel) is not bringing the needed increase in jobs and productivity required to reduce poverty.

A more inclusive, labor-intensive economic growth strategy is needed to reduce poverty and improve living standards.3

Diversifying the economy into labor-intensive sectors (agriculture, agroprocessing, manufacturing, tourism, etc) and increasing the competitiveness of domestic production to replace imports and diversify exports requires a new strategy focused on eliminating the barriers to private investment (both domestic and foreign).

To achieve this, Mozambique needs to remove the excessive amount of regulations that restrain economic activity, simplify the trade and tax regime, reduce the costs of hiring and firing workers, improve the skills of its labor force, eliminate the rigidity in land tenure, strengthen transport logistics and standards, while maintaining sound macroeconomic policies (fiscal, monetary and exchange rate policies).

While in the short-term there are good reasons to maintain some (better targeted) subsidies, accelerating the speed of reforms for this new economic growth strategy would be the best long-term response to the riots.

----------------------------1 World Bank (2008). Higher Food and Fuel Prices: Impacts and Responses for Mozambique. Report No. 47455-MZ. Washington. D.C.2 The convoluted policies affecting wheat products (including bread) merit a special mention. Import tariffs and VAT on food products have been eliminated (or reduced to 2.5 percent), except for a 20 percent tariff (15 percent for SADC countries) on milled grains (wheat and maize flour). This results into higher domestic price of flour which is paid by domestic consumers and protects/benefits the domestic milling industry (the bulk of which is constituted by 4 companies). This subsidy is worth about 0.3 percent of GDP (that is more than is spent annually on social protection programs). It would be possible to reduce the domestic price of wheat and maize flour by simply removing this tariff on imported milled grain (possibly to be combined with temporary direct assistance to milling industry to allow a gradual adjustment of this industry to external competition). Instead the government has decided to maintain the tariff, which keeps the price of flour and bread artificially high, and to introduce a separate subsidy to the bakeries in order to lower back the domestic price of bread.3 World Bank (2010). Mozambique Country Economic Memorandum: Reshaping Growth and Creating Jobs through Trade and Regional Integration. Washington. D.C.

Comments

But this time the riots were at least as much the result of misguided domestic policies as of international price volatility.
The Bretton Woods institutions have for years been praising Mozambique as a model country. Now they have riots, and all of a sudden you're throwing them under the bus. You guys did the same with Argentina.One minute they were a beacon of progress, then everything hit the fan and they were a hopeless basket case you wanted nothing to do with.

Well has a mozambican, and being someone who has followed events on the ground I can say, that I could see this coming milles away!!! I think the report disregarded the political factors, and focused only on the economic factors. But the political situation has to be tacken into acount, Mozambique has had the same party in goverment for over 35 years... its safe to say that FRELIMO has grown too acomudated with power, and they treat the hole country like it is theres, and they issue policies that only protect there interrests not necessarely those of the country has whole, they flount there imense wealth daily in the streets of the capital, and the extent of there corruption and whealth is wildly know to the general public. I agree with this report, I think it somes up pretty nicelly what has been happening in economic terms during the last 10 years in the country... wich is absolutly nothing

Clearly subsidies are an inefficient temporary response to a much deeper problem. Two decades of deregulation, lower wages, etc. are not "diversifying the economy into labor-intensive sectors" because foreign investors (who benefit from World Bank and IMF policies) are not interested. Mozambican entrepreneurs need a whole range of support structure -- not just credit but markets, training, and other support -- which in the rest of the world comes from the government. The Brazilian development bank is an excellent example of how to diversify the economy, but not for Mozambique because it goes against World Bank policy.
Small and medium scale commercial agriculture is the obvious way forward. But not long ago, the World Bank intervened to block the hiring of more agricultural expention officiers -- even after the Bank's own study showed they were effective and pro-poor -- because the government, according to the Bank, should not provide extension services. That is ideology gone mad.
In Malawi, a fertiliser subsidy (which may not be all the 'efficeint') has turned around agriculture, increasing income and ending the need for food aid. But the Bank and donors would never allow that in Mozambique.
If you look at the Mozambican commercial agricultural successes, tobacco and cashew, they are areas which have extensive outside intervention (tobacco by a multinational, cashew by a state institute) where markets are guaranteed and risks are shared.
What Mozambican farmers (and the domestic private sector in general) need is not more deregulation, but active intervention and support.

The other side of the coin in Mozambique is that the rich, a very small number, are becoming richer. They accumulate wealth and power, transforming any critique or observation, and protests, in a crime against the nation and the people. A profound change in the political and economic system -more democracy - will guarantee peace. The land law has to be changed. Profound changes have to be introduced in the ethical behaviour of the leaders and state personnel. International organizations as the World Bank - and donors in general - did not want to see that poverty alleviation in Mozambique was and is a void discourse. World Bank colleagues should look at poverty analisys of the 1980s in Mozambique. They will see clkearly that more than a reduction we have a growth of poverty and concentration of wealth in a very narrow fringe of society.